INVESTOR PREFERENCES for various market caps or sectors and themes tend to vary at different points in time. Whether any theme could see underlying sectors/segments rally or correct, depends on a host of business, macroeconomic and geopolitical factors. Who would have imagined a 25 per cent correction was coming in benchmark indices from September 2024 to early April 2025 after a stupendous multi-year rally earlier?
In the last 11 calendar years (2014-2024), the Nifty indices tracking banks were the best performers in four years, IT in two years, pharmaceuticals in three years, automobiles and commodities for one year each.
For retail investors, it would be nearly impossible to arrive at a decision on which theme would click at a given point in time.
Three specific challenges confront investors in arriving at the right conclusions. First, the inability to make the connection between macro factors and theme performance due to lack of expertise and time constraints. Second, the difficulty in containing emotions—fear and greed—especially during market extremes is a critical challenge. Third, the ability to shuffle and exit holdings in a tax-efficient way hurts or erodes overall returns.
To overcome these challenges, taking the mutual fund route is ideal for retail investors.
Theme identification challenges
As mentioned earlier, zeroing in on the right theme is fraught with difficulties for most investors.
When inflation and current account deficit were at alarming levels in 2012-13, investing in global markets such as the US would have been rewarding. Domestic infrastructure, banking, small and mid-cap investing would have grown manifold if it were done in 2014 after the new government came with a simple majority of its own.
In March 2020, domestic business cycle was at the bottom due to the pandemic. Investing heavily in equities at low valuations when supportive fiscal and monetary policies were in place would have at least doubled returns in the next 18 months.
Paring mid and small cap exposure due to soaring valuations, geopolitical tensions and weakening corporate earnings, and increasing cash position would have worked in September 2024, as markets cracked subsequently.
But making this macro to individual business connect is not within most retail investors’ ambit.
Handling emotions is even more difficult for retail investors. Not exiting IT stocks after a 740 per cent rally from February 1999-February 2000 due to greed would have resulted in a nearly 65 per cent correction over the subsequent one year.
When excessive fear gripped market participants in December 2012 due to eroding macroeconomic metrics, weakening currency and excessive corporate leverage, they would have missed a 60 per cent rally in the BSE IT Index and 27 per cent rally in the Nifty Pharma over the next one year.
Thus, investors may either end up overstaying in some themes while being too sceptical even when attractive opportunities present themselves.
Finally, shuffling sectors or themes inefficiently and following a poor exit strategy would mean high tax incidence and further erosion of returns.
Thematic funds show the way
When investors take the fund or fund of funds route to thematic investing, they can not only overcome the above challenges, but also gain a simplified, professionally managed approach. One such option is the ICICI Prudential Thematic Advantage Fund (FOF).
This fund takes into account macroeconomic factors such as inflation, interest rates, GDP growth, deficits, currency movements, IIP/PMI measures and the like and selects suitable themes/sectors for different environments. With the shortlist from the above process, valuation metrics are applied so that there is adequate margin of safety and overpaying for any segment is avoided.
Based on macro factors and valuation metrics, weightages for the underlying themes/sectors are assigned. A portfolio that strikes an optimal balance between being too concentrated and too diversified is ideal. Another key advantage is that the exit/reallocation strategy is decided by the fund manager based on the rigorous processes.
Additionally, gains from thematic fund of funds held for more than 24 months are now taxed at a flat rate of 12.5 per cent, compared to the earlier taxation based on the investor’s income slab.
As of May 30, 2025, the ICICI Prudential Thematic Advantage Fund (FOF) posted a robust one-year return of 20.85 per cent, with CAGR returns of 21.38 per cent over three years and an impressive 28.74 per cent over five years.
The writer is associated with FortunEdge Investment Services.